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RFS Advance Access originally published online on May 26, 2008
Review of Financial Studies 2008 21(4):1733-1765; doi:10.1093/rfs/hhn048
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© The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org.

Why Leverage Affects Pricing

Pegaret Pichler
Institute for Advanced Studies and Vienna Graduate School of Finance

Alex Stomper
Institute for Advanced Studies, Vienna Graduate School of Finance, and MIT Sloan School of Management

Christine Zulehner
University of Vienna

Address correspondence to Alex Stomper, 50 Memorial Drive, Cambridge MA 02142; e-mail: astomper{at}mit.edu.

JEL Classification: D43, G31, L83


  Abstract

We explain and provide evidence for effects of leverage on pricing. Our model identifies two effects that either counteract or reinforce each other, depending on the debt maturity structure: (i) firms set higher prices (underinvest in market share) if they have more debt, and (ii) firms engage in dynamic risk-shifting by setting lower (higher) prices if the current debt obligation will be higher (lower) in the next period than in the present period. Using a unique dataset of owner-managed hotels in Austrian ski resorts, we provide empirical evidence of both effects.

We would like to thank the referees, Michael Brennan, Jesus Crespo-Cuaresma, Sudipto Dasgupta, Ron Giammarino, Denis Gromb, Michael Halling, Gregor Hoch, Markus Hochradl, Hans-Georg Kantner, Vojislav Maksimovic, Robert McDonald, Dennis C. Mueller, Klaus Ritzberger, Judith Spiegl, Neal Stoughton, and Josef Zechner for helpful discussions and suggestions.


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